Guide to the most crucial bank meeting you never heard of

McClatchy NewspapersSeptember 10, 2010 

WASHINGTON — International bank regulators from around the globe will meet in the Swiss town of Basel on Sunday to finalize an important agreement that most Americans have never heard of: one to redraw rules so that banks can't bring the world economy to the brink of collapse again.

Federal Reserve Chairman Ben Bernanke is leading the U.S. delegation to the so-called Basel III talks. The assembled bank regulators are expected to agree to impose higher capital requirements on big banks. This would force them to keep more money in reserve to cushion against losses, one of the lessons of the near-meltdown in 2008, when banks had far more toxic assets on their books than funds to protect themselves against a downturn.

Here are some answers to questions about the weekend meeting and its importance, translated from bank speak to plain English.

Q: Do these Basel talks really matter?

A: This is the third incarnation of an international accord that seeks a floor, or common minimum standards, to which banks everywhere will be held. The first two Basel accords resulted from long, drawn-out and laborious talks that the global crisis in 2008 proved were insufficient.

Q: Why will these talks be different?

A: Political pressure around the globe, and recently passed U.S. legislation, make them crucial. Banks are unlikely to succeed now in pressuring politicians for weaker rules, and politicians in Europe, the United States and elsewhere are under pressure to fix what went wrong.

"Historically, the biggest impediment to any international agreement, but particularly on financial matters, is a concern about losing competitive position. If a couple of advanced economies go forward and others don't, you lose market share," said Vincent Reinhart, a former top economist at the Fed. "Politically, they want to get something done, so they (central bankers) are willing to move together ... and probably by more, and quicker, than the historic precedent."

Reinhart, who's now a scholar at the American Enterprise Institute, a conservative research center, added: "The stars are in the best alignment for getting something done now. The politicians want it, the industry is in a temporary setback ... and it is at a high enough public level of perception that there's pressure to do it. If they can't get it done now, nothing ever will happen."

Q: What will these regulators agree to this weekend?

A: They're expected to set new ratios for how much banks set aside to cover losses. Tier One capital, essentially the first buffer against losses, is likely to be doubled. The lack of adequate capital to offset losses is why governments in the United States, Britain and elsewhere had to intervene in the banking system to prevent massive failures in 2008.

Banks are also likely to be hit with what's called a countercyclical buffer, which will require them to set aside even more capital during good times, perhaps as much as another 3 percent of their total capital on top of the doubling of what they're now required to set aside.

The premise of this new requirement is that banks tend to lose sight of risk during good times, when there's more lending and investment, and this is the time to create even more protection to cushion against greater risks they're assuming. Inadequate loss provisions during the housing boom here and abroad hit the global economy with a vengeance in 2008.

Q: Didn't the recently passed financial revamp legislation in the United States do this?

A: The so-called Dodd-Frank Act empowered U.S. regulators to do this, but didn't mandate specific levels. Think of it as the playbook, and the rules of the game will come out of the Basel III talks.

"The Dodd-Frank Act was mostly about the location of activities, as opposed to a presumption that financial institutions would be more capitalized. Basel III is the first manifestation of the desire in Dodd-Frank to have more capital," said Reinhart, the former top Fed economist.

Q: So these central bankers really are going to agree on something?

A: Yes. A key Basel III committee reached an agreement Tuesday, which is expected to be publicized Sunday after international regulators sign off on the preliminary deal. Final approval of whatever is agreed on would come in November at a meeting of the G-20, representatives of the 20 largest global economies.

Less clear going into Sunday is whether bank regulators will agree to a global tax on financial transactions to cover the costs of cleaning up the financial crisis, and what sort of agreement there will be on leverage, or a bank's ability to invest more capital than it has. Many Wall Street banks were investing 30 times more than they had, another cause of the crisis.

Q: Would the Basel III rules take effect immediately?

A: From what word is leaking out, regulators apparently will leave themselves an out, thanks in part on insistence from Germany. There will be a long transition period, in many cases until 2018, before several of the new rules are fully phased in.

"When you get a long, drawn-out implementation, that leaves a lot of room for mischief and further interpretation," warned Bert Ely, a veteran banking consultant.

A long transition could result in an implementation that Ely likened to the shape of hockey stick, where the phase-in looks like a long handle that suddenly bends before reaching the end. The danger, he said, is that banks may delay complying until near the very end and then rush do to so in a confusing manner.

Q: Why such a long transition?

A: Part of it can be attributed to politics. Many countries don't want to take the bitter medicine until they absolutely must. There's a real concern, too, however, that the health of banks varies greatly across regions and even within countries. Forcing them to set aside more money cuts into their ability to lend and invest.

Just this week, Ireland was forced to take over some of its banks. In today's volatile environment, it's deemed prudent to avoid imposing burdens that could make things worse for financial institutions during the sluggish global economic recovery.

Q: As long as we have rules in the United States, why does Basel III matter?

A: The lack of a common set of rules agreed on by nations, particularly developed economies, led to a race to the bottom that eventually brought global finance to the brink of disaster. Seeking to take business from Wall Street and European markets, Britain offered a softer regulatory market that ultimately weakened the rules everywhere and created a less transparent financial system. Countries such as Iceland were offering depositors, many from nearby Europe, double-digit rates of return for savings accounts. Because there weren't sufficient rules, standards were weakened rather than strengthened.

"As events of the past have shown, financial stresses can quickly spread across national borders. Global financial stability is a critical shared goal," Daniel K. Tarullo, a member of the Fed's Board of Governors, testified before Congress in July.

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Daniel Tarullo's testimony

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